From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
There's been a subtle risk-on tone in recent weeks. With each passing day, it's been spreading to more and more markets and charts.
Rates are rising around the globe. The underlying uptrend in commodities is intact and looks ready for another up leg. Our equal-weight commodity index is resolving higher from its current range. And cyclical stocks such as energy and financials are breaking out to new highs.
All of these events speak to a growing risk appetite and support higher prices for risk assets.
Although, two areas where we aren't seeing such clear evidence that risk-seeking behavior is re-entering the market would be currencies and our intermarket ratios.
The AUD/JPY cross is still stuck within a range. High-yield bonds $HYG relative to their safer alternatives -- US Treasuries $IEI -- failed to hold their recent highs. And the copper/gold ratio is a hot mess.
We would expect to see decisive upside resolutions from these charts if investors are positioning for another leg higher.
This is not the case. At least, not yet.
But there is one forex cross that is hinting at higher prices for equities -- specifically Japanese equities. That's the USD/JPY.
Below is a weekly line chart of the USD/JPY pair:
Let's keep it simple here. New five-year highs and overbought momentum readings for USD/JPY is a major development that suggests a healthy risk appetite is upon us. This is definitely one for the bulls.
Now let's look at a weekly bar chart with some levels:
We’ve maintained a bullish outlook for the USD/JPY since it broke above its 2020 highs around 112 in early October. We're targeting the former 2015 highs around 125.90.
In the few months since putting the trade on, USD/JPY has marched steadily higher, recently eclipsing a key resistance level at the 2018 highs. This is a major level, as 2018 represents when risk peaked around the globe during the last cycle.
So, what does this pair have to do with the intermarket picture? Why is this action considered "risk-on"?
First of all, the USD/JPY isn’t one of those classic risk barometers that everyone watches like the AUD/JPY. At first glance, it’s quite the opposite. Instead of the risk-on/risk-off pairing of the AUD/JPY, the USD/JPY cross consists of two defensive currencies, the US dollar and the Japanese yen.
On the podcast last month -- which you can listen to here -- Paul Ciana made a great point about this cross. He pointed out that a true risk-on event often involves the dollar gaining ground against the yen.
When we overlay the USD/JPY with the Nikkei 225, a strong relationship between the two is evident:
Notice how the Nikkei 225 went nowhere from 2018 to 2020 as the USD/JPY trended lower. It wasn’t until we saw a sustained rally in the dollar-yen cross off its 2020 lows that Japanese equities began to catch higher and take out some critical levels of overhead supply.
In November 2020, the Nikkei 225 broke to new 29-year highs. It's currently consolidating at its highest level since the spring of 1991. These are huge multi-decade levels.
If the USD/JPY is making fresh highs and the Nikkei 225 is taking out multi-decade resistance levels, we need to look for opportunities to get long Japanese equities.
The Nikkei 225 is chopping around in a 12-month consolidation as it works its way higher from a giant base:
We want to buy a breakout on strength above the 2021 highs around 30,715 with a long-term target at the all-time highs just beneath 39,000.
Considering the size of this base in the Nikkei, once we get an upside resolution the ensuing rally could persist for years. But we have a while before we need to worry about that.
First, we need to see the index resolve higher from the current continuation pattern and take out those 1989 highs.
Let's think about the implications of all this now. If Japanese stocks are breaking out of a 30-year-plus base, what are other international equities doing?
They’re probably not going down! In fact, this would just be another chart to add to the growing list of base breakouts we're seeing from international stock markets.
Long story short, the evidence continues to build in favor of the bulls when we zoom out on our international indexes and ETFs... and Japan working higher from this base would be as bullish as anything.
So while the rally in the USD/JPY cross might not carry as much of a risk-on effect as a similar rally in the AUD/JPY or the copper/gold ratio, it’s the type of action we'd expect to see in a bull market. It’s definitely supportive of higher prices for risk assets, especially Japanese stocks. And that's what matters.
Maybe this is a sign of where other charts like AUD/JPY are headed from here. We'll be keeping a close lookout for it!
As always, let us know what you think.
And be sure to download this week’s Currency Report!
